Candy Crush: No terminal velocity

Δημοσιεύθηκε: 15 Αυγούστου 2014 - 13:43

The discounted cash flow exercise is a rote process for students of corporate finance. Estimate free cash flows for five or ten years and discount those back at an interest rate that reflects the risk of those cash flows. Then append a "terminal value" to the sum of the discounted cash flows - the value of the enterprise after the projection period ends. And therein lies one of the dirty, little secrets of DCF analysis: 90 per cent of total firm value can reside in the terminal value. This broaches the conundrum facing King Digital, purveyor of the Candy Crush mobile game. What if the best estimate of the terminal value is 0?

After releasing second-quarter results this week, King is exactly where sceptics thought it would be. King rocketed to $1.3bn in sales in 2013, from $38m in 2011 as Candy Crush exploded in popularity. Its backers, including Apax Partners, partially cashed out in an April listing. Candy Crush players have shifted their thumbs elsewhere, however, and King's newer games are not quite hits. It reported that it had 138m quarterly active users, down 5m from the first quarter. and it also lowered its view of full-year revenue growth. All this sent its shares tumbling a quarter. They are now a third below the IPO price.

Yet rarely is atrophy so profitable. King's cash operating margin is 40 per cent as it has been excellent at parlaying what users it has into dollars. King has $832m in cash, five times the level of a year ago (it did get $326m in IPO proceeds). Cash accounts for a fifth of its market cap.

Disappointingly, King does not pay a regular dividend. It did, as a peace offering, announce a $150m special dividend along with its earnings. But with its cash generation and fading growth it should aggressively be returning cash - perhaps all of it. Mobile apps are easy to design. But they peak quickly, then evaporate. When King spends dollars on R&D and M&A, it is betting that lightning will strike twice. King's managers - who are also shareholders - clearly think that the Candy Crush success was due to skill not luck.

King will is only the latest example of an enduring truth: public equity is bad form of financing for a decaying company, however profitable it may be.

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